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Wednesday, March 7, 2012

Despite SEC’s Protests to the Contrary, Has Judge Rakoff Set a New “Public Interest” Standard for Settlements?

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 On November 28, 2011, Judge Jed Rakoff roundly rebuked the Securities and Exchange Commission for neglecting its statutory mission and refused to serve as a “handmaiden” at the “whim” of the regulatory agency. The SEC alleged that Citigroup had misled investors in collateralized debt obligations, by stuffing a $1 billion mortgage fund with securities that were likely to fail. Judge Rakoff’s decision to reject the $285 million settlement in SEC V. Citigroup Global Markets was in line with his previous rejection of a similar ‘cost of doing business’ settlement in SEC v. Bank of America. Judge Rakoff stated that he was unable to exercise any independent judgment without enough facts to decide if the settlement was “fair, reasonable, adequate and in the public interest.”

Judge Rakoff set the case for trial July 2012. The SEC filed for an emergency stay which was granted by the Second Circuit. Meanwhile, Enforcement Director Robert Khuzami strongly defended the SEC’s settlement policy, as a critical tool of enforcement, emphasizing that the expediency of the “neither admit nor deny” policy protects the public interest by allowing the SEC to keep focusing on the next fraud case rather than wasting limited resources on lengthy trials.
On January 6, 2012, the SEC announced that it is dropping its long-standing “neither admit nor deny” settlement clause in cases where there are parallel criminal convictions although the SEC Enforcement director stated that the new policy is unrelated to the Citigroup case.

Also on November 28, SEC Chairman Mary Schapiro sent a letter to the Senate Banking Securities Subcommittee requesting legislation to turn the SEC from a toothless tiger into a more robust regulator, i.e. one with the authority to seek higher penalties and act against recidivist securities law violators.
Chairman Shapiro proposed five legislative changes. One change would increase the per violation cap to $1 million for individuals and $10 million for entities , an increase of $850,000 per violation for individuals and over $9 million increase per entity. She also requested the same monetary penalty relief in administrative proceedings as in court actions; authorization for a monetary penalty based on investor losses (which can be much greater than the defendant’s profit); and that the fine for authorizing penalties be increased to three times the defendant’s “gross amount of pecuniary gain.” Currently the SEC has no authority to recover investor losses.

On December 20, 2011, in Milwaukee, Wisconsin, U.S. District Judge Rudolph Randa rejected the SEC’s proposed civil settlement with executives from Koss Corp, a stereo headphone maker, accused of embezzling over $34 million, and required a “written factual predicate for why it believes the Court should find that the proposed final judgments are fair, reasonable, adequate, and in the public interest,” citing Judge Rakoff’s November 28, 2011 opinion.
The SEC responded January 24, 2012 with the details requested about disgorgement terms and Judge Randa expressed greater satisfaction that Koss would be required to implement appropriate changes and February 16, 2012 the revised settlement was accepted.

In the Koss matter, the SEC argues that Rakoff was wrong to conclude that the public interest had to be taken into account when reviewing the agency’s decision; nevertheless in its January 24 filing, Andrea Woods of SEC said that the Koss settlement had met that higher standard. Another example of SEC expediency -while awaiting the decision of the Citigroup appeal—arguing that the settlement met an even higher standard than required by law.

-- Laura Salisbury
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